THE expansion of China's domestic brand car sales, buoyed by the nation's stimulus measures, may hamper the ability of foreign auto makers to make further inroads in the market.

Domestic manufacturers reported that sales in the first two months of this year jumped after the central government halved the tax on new cars with engine capacities of less than 1.6 liters.

"Mainstream Chinese-brand vehicles have small engines that target price-sensitive consumers," said Zhang Xin, an analyst with Guotai Jun'an Securities Co Ltd.

The government is also granting 5 billion yuan (US$731 million) to subsidize farmers who replace commercial vehicles.

Led by BYD F3 and Chery QQ, sales of Chinese vehicle brands climbed to 131,700 units in February, accounting for a record 31 percent of the market, according to the China Association of Automobile Manufacturers. That compared with 25 percent last year for the Chinese vehicles. Foreign brands took the rest of the market.

Among the top 10 best-selling models, FAW Group's Xiali and the Free Cruiser from Geely Automobile replaced Toyota's Camry and Honda's Accord, two leading models, in the mid-to-high price segment.

Sales of sub-compact cars surged by 40 percent in February and models of domestic brands including Geely, Xiali and Zhonghua outperformed most others, according to a report from Automotive Resources Asia, a division of J.D. Power and Associates.

"The international brands are beginning to lose their grip on the sub-compact segment.

"Local companies are gaining more market share as they improve quality but are still able to keep costs low," ARA's report showed.

"The international brands still dominate the compact car segment, but similar to the sub-compact segment, local auto makers are gaining share on the back of growth in china's minor cities, where much of China's future growth will originate."

China wants to help its relatively small and underdeveloped automotive industry to grow after they spent most of the past decade assembling cars for foreign auto companies. More and more Chinese are buying their first cars as incomes rise under the nation's rapid economic development.

Besides the favorable tax policy, China also released a detailed blueprint for the auto industry last week that focuses on expanding manufacture of home brands and upgrading the technologies used in the domestic industry. The nation plans to invest 10 billion yuan in the domestic market, including technological innovation and research on fuel efficient vehicles.

Fuel efficiency

In the next two years, the strategy calls for domestic vehicle brands to take up to 40 percent of the auto market. At the same time, China wants to improve its competitiveness in the international market by increasing the fuel efficiency and safety standards of the cars it produces. It's hoping domestic vehicle brands will gain a 10-percent share of the country's overall vehicle exports.

The government will set an example by buying official cars from among domestic brands.

Executives of major domestic car makers, including Wang Fengying from Great Wall Motor Corp, proposed that step during a recent session of the Chinese People's Political Consultative Conference.

"Government promotion is just part of the story," said Lin Huaibing, an analyst from consulting firm Global Insight, who estimated that the market share of domestic brands would reach 40 percent within 10 years even without strong government backing.

"In the long term, the market share of China's domestic brands will continue to expand as domestic car makers make progress on brand awareness, design, safety and fuel economy," he added.

"Although they still lag far behind foreign car makers, the gap is narrowing," Lin said.

The robust sales increase has lead to aggressive expansion plans.

Chery said it will launch 10 new models this year and is diversifying into minivan and light commercial vehicles that are in strong demand in rural areas. Geely said it will boost sales by 25 percent to 281,000 units and eight models will be launched, including its first mid-to-high price sedan.

BYD, partly owned by Warren Buffett, aims to sell 400,000 units this year and said five new models are in the offing.

The emergence of Chinese domestic brands poses a direct challenge to overseas car makers, particularly at a time when they are facing sales slumps and financial losses.

Many Japanese, American and European car makers are looking at the Chinese market to help them ride out the recession. Some, like General Motors, said their Chinese operations have been a bright spot in an otherwise gloomy profit environment. Although China hasn't been immune to the global downturn, its auto market is managing to post gains. With foreign rivals on the skids, China has surpassed the United States as the biggest market in the world for new car sales.

China's vehicle sales rose 6.7 percent to 9.38 million units last year, the first single digit growth rate in a decade. Vehicle sales in the first two months of 2009 climbed 2.7 percent to 1.56 million units, compared with a 39-percent drop to 1.35 million units in the US as consumer credit dried up and discretionary spending plummeted.

"The market potential in China is so huge that it can't be ignored by any international car makers," said Lin. "Foreign car makers, in response to Chinese consumer preferences, are adopting strategies to be more competitive on the pricing and styles. It takes time but it's definitely worth it for them."

Compared to aggressive Chinese car makers, most international auto groups, including General Motors Corp and Ford Motor Co, have lowered global sales expectations for this year below 10 percent.

But foreign auto makers say they will continue to invest in China. Volkswagen has announced it plans to double sales in China to 2 million over the next 10 years.

Foreign auto makers are planning new models and advanced technologies for the China market, including direct fuel injection vehicles to improve fuel efficiency.

The Pan Asia Technical Automotive Center, GM's automotive engineering and design joint venture with Shanghai Automotive Industrial Corp, opened China's most advanced vehicle safety testing lab earlier this month.

GM's Chevrolet Cruze compact, which goes on sale in China in the second quarter, will also get a new 1.6-liter turbocharged engine.